NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Reserve Requirements on Sovereign Debt in the Presence of Moral Hazard -- on Debtors or Creditors?

Joshua Aizenman, Stephen J. Turnovsky

NBER Working Paper No. 7004
Issued in March 1999
NBER Program(s):   ITI

This paper characterizes the effects of reserve requirements on financial loans in the presence of moral hazard on the lender side (i.e., the anticipation that the taxpayer will bailout lending banks if large default will occur) and sovereign risk on the borrower side. The impacts of such reserve requirements on the equilibrium degree of default risk and borrowing are analyzed, and their welfare implications for both the borrowing and the lending nations discussed. More generous bailouts financed by the high income block encourage borrowing and increase the probability of default. We show that the introduction of a reserve requirement in either country reduces the risk of default and raises the welfare of both the high income block and the emerging market economies. In these circumstances, the lender's optimal reserve requirement is shown to increase with the expected bailout. Such a policy induces the lender to internalize the expected tax payer cost of the bailout. Thus a more generous bailout that is accompanied by an optimal adjustment in the lender's reserve requirements exactly neutralizes its effects on welfare, leaving welfare in both countries unchanged. Unlike the case of the lender, the effect of the more generous bailout on the borrower's optimal reserve requirement is ambiguous. The imposition of the reserve requirement may also improve the availability of information about the debt exposure of the emerging market economies, which by itself will reduce the optimal lender's reserve requirements, and may prevent drying up' the market for sovereign debt.

download in pdf format
   (181 K)

email paper

This paper is available as PDF (181 K) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w7004

Published: Aizenman, Joshua and Stephen J. Turnovsky. "Reserve Requirements On Sovereign Debt In The Presence Of Moral Hazard - On Debtors Or Creditors?," Economic Journal, 2002, v112(476,Jan), 107-132. citation courtesy of

Users who downloaded this paper also downloaded these:
Cothren and Waud t0101 On the Optimality of Reserve Requirements
Lochner and Monge-Naranjo w13912 The Nature of Credit Constraints and Human Capital
Courtemanche and Snowden w16245 Repairing a Mortgage Crisis: HOLC Lending and its Impact on Local Housing Markets
Calomiris, Mason, and Wheelock w16688 Did Doubling Reserve Requirements Cause the Recession of 1937-1938? A Microeconomic Approach
Grossman and Van Huyck w1673 Sovereign Debt as a Contingent Claim: Excusable Default, Repudiation, and Reputation
 
Publications
Activities
Meetings
NBER Videos
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us